ISLAMABAD, Pakistan—The Pakistani rupee dropped steeply against the dollar Tuesday after the government said it was seeking a bailout from the International Monetary Fund, which will likely lead to tough economic policies and slow the nation’s economic growth.

Prime Minister Imran Khan’s new administration was forced to turn to the lender of last resort after its planned alternatives to the IMF didn’t work out, officials said, especially aid from Gulf nations.

Economists say the government needs to raise some $12 billion to head off a financial meltdown from its inherited crisis of a mushrooming trade deficit and dwindling foreign-exchange reserves.

The new government of Prime Minister Imran Khan will likely have to rein in spending and increase taxes.

To the alarm of the markets, Mr. Khan’s nationalist government had suggested it could make do without the IMF by raising enough cash through grants and loans from other countries, bond sales and money from overseas Pakistanis. Officials say the government hoped in that way to either avoid the IMF or make any loan much smaller and therefore have less onerous strictures attached.

In particular, Pakistan was looking for cash injections from China, Saudi Arabia and the United Arab Emirates. Mr. Khan visited Saudi Arabia and the U.A.E. last month to ask for financial assistance. But so far, the requested cash hasn’t materialized from the Gulf. China has provided loans in recent weeks in addition to several billion dollars of short-term lending over the last two years, officials say.

Chaudhry Fawad Hussain, Pakistan’s information minister, said Tuesday that Saudi Arabia and the U.A.E. put unacceptable conditions on providing any money. He didn’t spell out what strings were attached, but in the past those Gulf states have pressured Pakistan to join their war against Iran-backed Houthi rebels in Yemen and pushed for Islamabad to enlist in their campaign to isolate their regional rival Iran
Pakistan is close to Saudi Arabia but at the same time has sought not to antagonize Iran, with which it shares a long border.

“There are no free lunches,” said Mr. Hussain, speaking on a local television station. “Nations look after their own interests.”

There was no immediate reaction from Saudi Arabia or the U.A.E.

Pakistan’s new government, in power for less than two months, had promised millions of new jobs and the creation of what it called an “Islamic welfare state.” Instead it now looks more likely to have to rein in spending and increase taxes under an IMF program.

“Decisive policy action and significant external financing will be needed to stabilize the economy,” the IMF said last week after a visit by the organization’s officials to Pakistan.

An IMF loan would have to cover most of Pakistan’s financial shortfall and would likely come with strict terms for fiscal reform—posing a difficult situation for Pakistanis as the weak rupee leads to higher inflation.

A rescue from the IMF will also be embarrassing for China, Islamabad’s closest ally, which had made Pakistan the showcase for its global infrastructure-building program. Cutbacks in that program can be expected along with IMF scrutiny of Pakistan’s financial obligations to China, Pakistani officials said.

China is building roads, power plants and a port in a $62 billion program in Pakistan.

The IMF move will also push Pakistan into the crossfire of the continuing economic confrontation between China and the U.S. Washington, which has accused Beijing of “debt-trap diplomacy,” said in July that any IMF bailout for Pakistan shouldn’t go toward paying off China.

Imports from China are the biggest nonfuel contributor to the country’s trade deficit. Pakistani officials privately say they would like to renegotiate a free- trade deal with Beijing to make it better for Pakistani businesses, which complain it allows unfair competition from China.

The Pakistani rupee fell as much as 10.2% to 137 rupees to the dollar on Tuesday before regaining some ground. That isn’t far from the biggest-ever, one-day fall of 11% after Pakistan tested its nuclear weapon in October 1998.

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Investors are betting the IMF will want to see the rupee weaken to around 145 to the dollar, said Tahir Abbas, vice president for investment research at brokerage Arif Habib.

“The IMF will want to see the economy cool off, to reduce demand in order to manage the current-account deficit,” he said.

A weakening currency helps a country’s trade balance by making exports cheaper and imports more expensive.

Many economists believed the previous government of Prime Minister Nawaz Sharif supported the Pakistani currency at too strong a level. Only in its last few months did it allow the rupee to depreciate. The rupee is now around 30% lower than it was late last year.

Pakistan is already scaling back China’s infrastructure-building initiative in the country under the new government, but because of Pakistan’s reliance on China, the retrenchment is being done discreetly.

Around a third of the planned Chinese projects are already under way or completed—financed by Chinese loans or an obligation to buy electricity from new Chinese power plants. The new government still has to decide—now likely with IMF input—on the fate of the rest.

With less government spending, economic growth will likely slow to less than 5% this year after hitting a 13-year high of nearly 6% last year, analysts say.

An IMF spokesman said it hadn’t yet received a formal request for a program from Pakistan’s authorities.
“However, we understand that Pakistan intends to approach the IMF for support. Once we receive a formal request, the IMF will consider it as it does for other members of the IMF,” the spokesman said.